An effective tax plan is a necessary part of your overall financial plan. Making the right tax moves can significantly reduce your tax liability, leaving more money in your pocket. However, there are common mistakes that individuals often make. Let’s explore these pitfalls and how to avoid them:

1. Roth Timing
Roth accounts are a popular way to save for retirement as potential earnings grow tax free. What is often overlooked is the timing of your contributions. Making Roth contributions during high-earning years may not be the best strategy. High earners could benefit from deferring taxes now and paying them later in a lower tax bracket.

2. Selling Stock for Cash to Give to Charity
Instead of selling stock and donating the cash, consider donating the stock directly to a charitable organization. This offers benefits for both the recipient and the donor.

Donors who have held the stock for over a year can deduct the entire fair market value of the stock as a charitable contribution, and avoid capital gains tax. The recipient organization, in turn, receives a larger donation compared to receiving the proceeds after taxes.

This approach maximizes the charitable impact and provides tax advantages for the donor, making it a beneficial arrangement for all parties involved.

3. Not Understanding Deductions
Did you know that almost 90% of taxpayers take the standard deduction? Be aware that certain deductions (e.g., mortgage interest, charitable contributions, property taxes, medical expenses) are only applicable if you itemize.

If you do not itemize your taxes, do not count on tax deductions for major financial decisions.

4. Unnecessary Tax in Your Brokerage Account
Holding investments long-term (for at least one year) provides significant tax advantages. Let’s illustrate this with an example:

Scenario: You have a $100,000 gain and plan to sell.

Short-term gain: $24,000 or more (taxed as ordinary income)
Long term gain: $15,000 (taxed at long term rates 0%, 15%, or 20%)

Holding the investment for one year or more results in $9,000 tax savings.

5. Underutilizing Retirement Plan Contributions
Retirement plans are one of the best ways to legally pay less taxes. Whether through employer-sponsored plans or individual retirement accounts (IRAs), taking advantage of retirement plans can lead to substantial tax savings

The most common retirement plan is the 401(k) and for 2024 you can contribute $23,000 or $30,000 if you are 50 or older.

6. Ignoring the Benefits of HSA
Health Savings Accounts (HSAs) offer triple tax advantages, making them a powerful tool for tax planning. Contributions are tax-deductible, earnings grow tax-free, and withdrawals for qualified medical expenses are tax-free.

The main disadvantage to this plan is it requires a high deductible health plan (HDHP). If you have HDHP, an HSA account might be worth looking into.

7. Withholding Too Much or Too Little
Withholding too much tax can result in an interest-free loan to the government. On the flip side, withholding too little can lead to penalties. Use the safe harbor guidelines below to avoid underpayment penalties:

    • Pay at least 90% of the tax you owe for the current year, or 100% of the tax you owed for the previous tax year
    • If your adjusted gross income is above $150,000, you need to pay at least 90% of the tax you owe this year or 110% of last year.

8. Operating Under the Wrong Business Structure
Selecting the appropriate tax entity for your business is crucial. While many small businesses opt for sole proprietorships or limited liability companies (LLCs), these may not be the best option. Factors influencing the decision include the desired business structure, the number of employees, and financial goals. Among the potential entities available for small businesses are:

    • LLC
    • C-Corp
    • S-Corp
    • Partnership
    • Nonprofit

Consulting with a Certified Public Accountant (CPA) or a CERTIFIED FINANCIAL PLANNER™ can provide personalized guidance based on your specific situation.

9. Not Recording 1099-R Transactions Correctly
Accurately recording 1099-R transactions is essential to avoid paying taxes on distributions that shouldn’t be taxed.

Let’s say you rolled over a 401(k) to an IRA rollover. The custodian is going to send you a 1099-R for the distribution. It’s important to make sure this transaction is reported correctly to avoid paying taxes on something you don’t have to.

10. Forgetting to Take Your RMD
Forgetting to take your Required Minimum Distribution (RMD) is a costly mistake. The IRS assesses a 25% penalty on the RMD amount if you don’t take it by the deadline. Automating your RMD withdrawals can help you stay compliant and avoid unnecessary penalties.

Bottom Line
Understanding these tax mistakes can help you make informed decisions. Seek professional advice when needed, and stay proactive in managing your taxes.

George Maroudas, CFP®

George Maroudas, CFP®

847-550-6100
george@pmgwealth.com
Twitter @ChicagoAdvisor

Disclaimers/ Sources

Estimated Tax for Individuals (Safe Harbor) from IRS.gov.
11.4% of Taxpayers itemize from IRS.gov

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

 This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.